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10/31/2010

The United Kingdom’s Dramatic Response to the Economic Crisis—Posner

The new coalition government in England is embarking on an ambitious austerity program. One goal is to eliminate 490,000 jobs in the public sector; a related goal is to slash government expenditures by 19 percent over the next four years. Administrative budgets—overhead—of government agencies are to be slashed by 34 percent. (The U.S. population is five times as great as the U.K.’s—so imagine our eliminating 2,450,000 public sector jobs!) By a combination of tax increases and spending cuts, the U.K. government hopes to eliminate the annual national budget deficit, currently more than 11 percent of GDP (similar to ours), by 2015. Among popular programs to be trimmed or eliminated are housing subsidies for middle-class persons. Defense expenditures are to be reduced by 8 percent, education spending by 3.6 percent, and the teaching budgets of public universities by 40 percent. Since spending on technical subjects is to be protected, other disciplines, such as the humanities, will face especially steep cuts and tuition will rise.

England can make dramatic changes in policy overnight because its government is extremely centralized. The Cabinet dominates the House of Commons, thus fusing the executive and legislative branches (the legislative branch is effectively unicameral—the House of Lords counts for little), and except in Scotland and Wales, there is no regional autonomy, as there is in the United States by virtue of our federal system. Except in wartime, we cannot make major policy changes in a hurry, though the Obama Administration managed in two years to make more changes than any President, in a comparable period, since Lyndon Johnson (and much of the groundwork for his “Great Society” legislation had been laid in the Kennedy Administration and gained momentum from Kennedy’s assassination).

England’s economic crisis is a great deal like ours; its response has been dramatically different. England, Keynes’s homeland, has rejected the Keynesian solution to depression or recession, which is to stimulate consumption by deficit spending aimed at increasing the incomes and confidence of the public; the Obama Administration has embraced the Keynesian approach (which Americans call “stimulus’), though its implementation has been erratic, in part because of deficiencies of timing, design, and execution, and in part because of political resistance.

But the two nations’ diametrically opposed approaches have this in common: both proceed, in part, from a desire to use an economic crisis as an occasion for long-term economic reform. Both administrations are looking beyond the crisis. Both believe that the crisis has made the public receptive to reforms that they would resist in times of prosperity. The English government, being dominantly although not entirely conservative (for it is a coalition government and the Liberal Democratic Party is the junior member of the coalition), wants reform in the form of a leaner government. Our government, being dominated by liberals (at this writing, though perhaps not for long, both Houses of Congress, as well as the Presidency, are Democratic), wants a larger government, which will expand public subsidies of health care, increase regulation (and not only of financial institutions), and combat global warming with taxes and subsidies.

Both approaches risk making the economic crisis, which as I said is similar in both countries, worse in the short run, though long-term benefits of the attempted reforms may outweigh present costs. England is slashing public payrolls and subsidies at a time of high unemployment and economic anxiety, and this may reduce economic growth in the near term. The U.S. government is frightening business by its regulatory measures, the health reforms that may well increase the labor costs of business, the prospect of higher taxes, anti-business rhetoric, and a general ambition to make government larger and more aggressive, which is unsettling the politico-economic environment of business. There is a sense too that in their impatience to bring down the unemployment rate, the Federal Reserve and the Treasury may soon embrace policies that sow the seeds of future inflation. Uncertainty causes businesses and consumers alike to tend to freeze—to save (in “safe” forms that don’t promote productive investment) rather than spend—and the Obama Administration has increased the level of economic uncertainty in the United States.

Unfortunately, as we have learned in the last two years, the economics of the business cycle, and in particular of the business cycle when it enters a deep trough, are not well understood. It is possible to tell a “story” about how the English program will stimulate investment and consumption by convincing businesses and consumers that a leaner government will conduce to faster economic growth. But there is an equally plausible “story” about how the English program will reduce growth by reducing employment and incomes, and that what both England and America need is further deficit spending to increase incomes and employment. There is too much uncertainty, compounded by the dramatic economic changes occurring in major trading partners of England the United States, to be confident that one “story” is true and the other false.

What may make the prospects for England brighter than those for the United States regardless of which story is true is that the English people are famously patient and stoic, and the English government as I said unusually centralized, and this combination may give the government flexibility in adjusting its policies to changing economic conditions. If anti-Keynesian policies don’t work, the government can switch to Keynesian policies.

We don’t have that flexibility. Not only is our government highly decentralized, but our politics appear to be approaching gridlock, in which neither political party will either raises taxes significantly nor cut public spending significantly nor even resist new spending programs. The Keynesian approach has been discredited, whether rightly or (as I think) wrongly in this country, but fiscal rectitude (as one might call the English approach) seems unattainable here as a political matter.

Comments

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You refer to "England" and the "English government" when in fact you mean "Britain" and the "British government".

England does not have its own Parliament or Government. It is one of four countries - along with Scotland, Wales and Northern Ireland - that make up the United Kingdom of Great Britain and Northern Ireland. The policy of fiscal tightening to which you refer is being carried out by the British government.

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The previous Labour administration (since 1997) ran a large deficit during a time of growth. When the financial crisis hit and our financial services industry had to be supported, borrowing went through the roof.

So while a Keynesian stimulus is the orthodox and preferred route toward growth, it's only viable if you've run a Keynesian macroeconomic policy over the length of the business cycle.

Everyone's a Keynesian when times are bad. But unless you've paid back some national debt during growth, you're simply transferring the price of today's recovery to your children.

So nobody in government wants to sack half a million public sector workers, or raise taxes (VAT in particular), or slash benefits to the poor. But profligacy rather than prudence during years of growth has left little room for manoeuvre.

One final point. The spending cuts are spread over four years. This means that the average 20% departmental cut is actually only a 5% cut each year. At the end of this period, 2014/15, UK public spending will be roughly what it was in 2007.

So with all sympathy to those affected by the cuts, it's hardly Armageddon. Civilisation will endure. It's not exactly a State of Nature either - the UK will remain European in its spending and attitude to State intervention.

Might I suggest that the good professors and the readers of this blog re-read the mythological life of Sysyphus and his ultimate fate for his misdeeds. While it is always good to argue the details of macroeconomics, our professors might be more instructive if they were to re-define human nature and the repititious nature thereof. Stated simply, will we ever learn or will we have to wait for some Malthusian disaster to make the management of societies more facile.

The remarks written by Rick above are interesting on a number of levels.

First of all it should be obvious that an economy has to be managed over the whole cycle and not just in recession yet, perhaps because of the extreme situation the US finds itself economic foresight does not extend beyond the end of the year.

Next the lack of vituperation should be noted. The Labour government was not criticized because for being "left wing" or "socialist" but for its profligacy.

Posner rightly says that the British system of government is more centralised than that of the US which is true. However because the governing Conservatives do not have a majority in Parliament they can be tossed out at anytime which makes their program a remarkable success at consensus building.

I look forward to seeing what, if anything, the UK does about the financial services monster it created.

So nobody in government wants to sack half a million public sector workers, or raise taxes (VAT in particular), or slash benefits to the poor. But profligacy rather than prudence during years of growth has left little room for manoeuvre.

Has anyone looked at the relationship between population number, government services required at a minimum for that population,revenue required for those services and tax requirements which allow for that revenue. In other words, do fewer people reduce government cost per person and/or inefficiency.

"Defense expenditures are to be reduced by 8 percent, education spending by 3.6 percent, and the teaching budgets of public universities by 40 percent."

.......... My god! Cut the military! If the US trimmed our bloated military budget, which costs us twice as much per capita as Britain spends, by 8% it would be nearly $50 billion/year; a sum that is still small compared to the deficit, but it will be difficult -- if not politically impossible to carve a similar amount from other areas.

Ha! are we so incompetent at warmongering that we have to spend as much as does the rest of the world combined???

F-35 program will tally over a TRILLION this decade to supply 2,500 planes. A wise use of scarce public dollars?

As for the different approach between us and Britain, we have some $2 trillion in needed infrastructure repairs and upgrades. Also it could be argued that we are still a developing nation in which public investment now will pay far more dividends in the future than will a kneejerk attempt to "cut" our way out than would a few "saved?" dollars.

Consider: As Feds and states chop jobs, in this Mess, many will go straight to the unemployment, early SS, or welfare rolls, which will leave them with even less to spend in a nation some 75% dependent on consumer spending. Better to "go down" if need be, swinging and fixing up our tattered nation than idling at home doing nothing........ or worse.

Lastly? MAYBE a "Keynesian" should save during the good times in order to have some ammo when the predictable recessions come. But, maybe not.

IF deficit spending spurs an economy, then during the apex of the Clinton era boom it could be argued that the much vaunted balanced budget and surplus was too contractionary. In any case in our nation it soon draws a political tax cutter!

So was the Bush admin wrong to run deficits during their early recession and the "jobless recovery?" Perhaps not, instead their mistake was the costly tax break for the wealthy which we know is a weak means of spurring demand; as many dollars collected and spent on infrastructure and beginning transitions such as conserving fossil fuel and developing domestic alternative would have provided FAR more "bang for the buck".

Those poor souls at the top of the heap having to ante up a bit more in taxes? My guess is they'll get more in a strong economy than they would from a tax break in a poor economy.

"But there is an equally plausible “story” about how the English program will reduce growth by reducing employment and incomes, and that what both England and America need is further deficit spending to increase incomes and employment."

.......... Britain may want to experiment with a contractionary cutting approach and with just a $2 trillion economy the results may matter little to the rest of the world, but the US $14 trillion economy is the super locomotive that hauls along most of the economies of the world. If we cut and put our people out of work the effect will echo and likely amplify around the world and come back to our doorstep.

It's a MESS but at this point keeping our people working and rebuilding momentum is worth a lot more than trying to cut a few bucks off the deficit. Now why IS it that our Chicago boys do not even mention allowing the poorly thought out Bush tax cuts for the wealthy to expire? Surely they've seen this or a similar graph:

I agree with you but would like to add that waste in both the private and public sector is a huge monetary drain.

On another subject, while buying a pair of sport shoes the other day, I asked the purveyor what was the "average cost of a pair of sport shoes in the US across all levels of quality. His answer was $60.00. So I postualed bring all shoe manufacturing jobs back to the US and asked him what the average price would be in that case. His answer was $250.00. No one here would be buying shoes and either the industry would disappear or the wages of shoemakers would have to be reduced by a factor of 4. My point being that all things being equal, the US standard of living is coming down and to make the economy grow, new innovation jobs will have to be found and right now our education system and government policies are not geared for that. We are being out innovated by a whole slew of countries even with their low labor costs. When I look at Hiroshima and see what the Japanese have done in rebuilding it into a magnificent modern city in 60 years after a nuclear bomb was dropped there and then look at Detroit in the same years, I really wonder if we have what it takes. By the way, what happened to the 1000 years of radiation fallout that was supposed to make Hiroshima uninhabitable? Just curious.

Jim: While agreeing with the concept that shoe sewing jobs may best be left to low wage countries I think your shoe purveyor greatly exaggerates. The shoe biz is already highly mechanized and were we to HAVE to make our own tennies I'm sure it would be far more mechanized.

I've (semi) bought the "leading innovator" pitch.. ala Apple designs the Iphone with 25,000 employees while ten times as many assemble it in China. But! as fast as tech moves these days........ how long before the whole thing is "over there?" Consider the short timeline of Japanese making kinda junky little cars, then competitive, then leading for a considerable time.

Another problem? How many folks do you know who are "innovators"??" Truth is no matter how high the educational level we'll require all those blue collar, retail clerks etc....... and currently there is no way for the profits of the innovators to increase the long stagnant wages of working folk. It seems simple equation: Stagnant wages for the middle and lower class millions equates to a stagnant (or worse) economy.

(A universal H/C system paid in part through taxes would be one means of lessening the (too) steep income curve AND those in mid-life assured of decent H/C would be far more inclined to build or join a start-up biz or innovate)

I don't know what Hiroshima did to clean up, I suppose the daunting task of removing earth?

Detroit: I've never been there but have spent time in Chicago (though Ha! not at the Milton Friedman Memorial Econ school) but looking at a map it would seem Detroit will have another day. A port city with all those freeways converging? Though transportation, iron ore and infrastructure for a past era of mfg aren't as important these days, I'd bet something will revive Detroit. With homes and factories being sold by the sixpack someone will have to take advantage!

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